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Living annuities: Is a drawdown best taken from a local fund?

If the aim is to get maximum global exposure and the drawdown is taken 100% from local funds, how much should be invested in the local fund?

My questions relate to broad principles in investing in a living annuity.

I am retiring from a retirement annuity (RA) and will be investing in a living annuity. The reason for retiring from the RA is to allow global investment and not be restricted by Regulation 28. As an income from drawdown isn’t needed, the minimum drawdown will be used for the foreseeable future; R500 000 will be taken as cash upfront to use the non-tax advantage. 

My questions relate to the distribution of the remaining funds to be invested in light of the above: 

  1. Is a drawdown best taken from a local fund such as a money market or income fund or drawdown proportionately from all funds including the global funds?
  2. If the aim is to get maximum global exposure and the drawdown is taken 100% from local funds (depending on the answer to question 1), how much money should be invested in the local fund? Is it calculated on enough to cover 2/3/10 years of drawdown before needing redistribution?
  3. Is an exchange-traded fund (ETF)) an absolute no-no in a living annuity because of brokerage fees, with the caveat that drawdown will NOT be taken from the ETF except if a top-up may be needed for funds where drawdown is taken monthly? Therefore brokerage fees won’t be incurred on a regular basis.
  4. Is tax like capital gains tax (CGT) paid on drawdown?
  5. If a large percentage is invested globally, and my risk is moderate, should the investment be diversified, and which groups of funds (equity, bonds, cash) should be considered? 
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I am retiring from an RA and will be investing in a living annuity….As an income from drawdown is not needed, the minimum drawdown will be used for the foreseeable future; R500 000 will be taken as cash upfront to utilise the non-tax advantage. 

Expediting a retirement decision needs careful consideration as some irreversible decisions are brought forward, sometimes prematurely. If none of these implications from your ‘early retirement’ are considered harmful, investors can retire from an RA/pension/provident/preservation funds after the age of 55, subject to specific fund rules. This strategy could make a lot of sense if investors are not already sufficiently diversified across their investment portfolios (including discretionary funds). Be careful not to only consider a scenario of currency depreciation or a continued South African economic contraction. Your overall financial position should be considered holistically, in light of your fixed property and other liquid/illiquid assets, if any.

Assumption: Your RA is commuted into a living annuity holding indirect offshore (asset swap) unit trust funds (similar risk profile; moderate).

My questions relate to the distribution of the remaining funds to be invested in light of the above:

1. Is a drawdown best taken from a local fund such as a money market or income fund or drawdown proportionately from all funds including the global funds?

I prefer to use an asset-liability matching strategy, which includes a conservative component from where you finance monthly income drawings. This allows the advisor to take sufficient risk with the remainder of the portfolio. ‘Income certainty’ seems to provide many investors with sufficient comfort to commit to a growth strategy with the remainder of the assets.

2. If the aim is to get maximum global exposure and the drawdown is taken 100% from local funds (depending on the answer to question 1), how much money should be invested in the local fund? Is it calculated on enough to cover 2/3/10 years of drawdown before needing redistribution?

The time horizon for local conservative funds is generally three years or shorter. If you are considering the minimum 2.5% per annum drawdown, generally two years’ income provision from conservative funds should be sufficient. Seeing that the remainder of the portfolio is all offshore (balanced) funds, I would suggest keeping at least 10% of the portfolio in local conservative funds to absorb exchange rate volatility.

Should investors opt for a greater growth strategy (for example, only offshore equity), I suggest that your income provision doubles, keeping around 20% in local conservative funds.

3. Is an ETF an absolute no-no in living annuity because of brokerage fees, with the caveat that drawdown will NOT be taken from ETF except if a top up may be needed for funds where drawdown is taken monthly? Therefore brokerage fees will not be incurred on a regular basis.

ETFs (passive unit trust funds) can be used within living annuity/retirement solutions, as long as their asset allocation is appropriate to the client’s risk profile. I would however not allocate more than 10% to 15% to only one passive strategy in any solution.

ETFs sound compelling from a cost perspective but few investors, (if any) are willing to see their investments halved during a market crisis.

4. Is tax like CGT paid on drawdown?

Income drawdowns are included in your taxable income. Living annuities incur no tax on dividends and interest earned or capital gains made.

5. If a large percentage is invested globally, and my risk is moderate, should the investment be diversified, and which groups of funds (equity, bonds, cash) should be considered? 

Assumption: Max exposure offshore

Considering that you are not income-dependent yet, together with the rand absorbing equity market volatility, one can (for moderate) consider the following asset allocation:

a). 10% local conservative / income funding allocation;

b). 15% global cash / global bonds; and

c). 75% global equities.

If this is the only retirement provision you have, I will include balanced funds for the core 90% of the portfolio, 10% in RSA for income drawing (still assuming 2.5% – four years of income).

Should you need to withdraw more income at a later stage, I would suggest that your portfolio be rebalanced annually.

Please bear in mind that multiple other considerations (e.g. age, wider financial means, dependents, etc.) can play a significant role in the portfolio construction.

Do you have any questions you would like answered by registered financial planners?

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COMMENTS   2

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This advice seems completely flawed. Of course you can use ETFs for asset allocation strategies!

For the above suggestion of 75% global equities, for the Global Equities component, few global funds have beaten Sygnia Itrix World or Satrix World over varying time periods (and this has changed little, having watched the objective data at Profile Fundsdata for more than a decade). It is gobsmacking that Fund Managers, which have the whole world as their investment paradise are so dismal at beating passive funds and ETFs. Sygnia World is 10th out of 58 global funds and satrix World 14th over 15 years. Similar patterns for 1 and 3 years, and little changed in pattern over the past decade (have watched this for a long time). The only thing that changes are the names of the few near the top, which are different every year or 3 (likely largely reflecting chance/noise)
Furthermore, data from other countries consistently shows the same thing! Look at Morningstar and Sp&P data

For a local Conservative portfolio, Sygnia offers ranges of the passive portfolios, and little surprise that they all come near the top of their asset classes, because costs matter. Have a look at the various categories at Profile Fundsdata. Sygnia Skeleton Balanced 70 is 17th out of 165 funds over 5 years and Satrix 26th out of 165 funds in the Multi-Asset High Equity Category.

In the Multi-Asset Medium Equity category, Sygnia Skeleton Balanced 60 is 3rd th out of 77 funds over 5 years.

In the SA Multi-Asset, low Equity, the Sygnia Skelelton Balanced 40 is 7th out of 140 funds over 5 years
http://www.fundsdata.co.za/scripts/home/QuickRank.aspx?c=South%20African–Multi%20Asset–Low%20Equity&period=5yr

Read this too
https://us.spindices.com/spiva/#/reports
https://www.morningstar.com/lp/active-passive-barometer

No surprise, in USA and other places, global fund managers also have a low probability of outperforming passives over the medium and long term

I agree 100%.Sygnia have excellent index funds which are also cost effective and give decent returns. Managers like Allan Gray, PPS etc etc are still way to expensive for the poor returns.

End of comments.

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